Q: I
founded a company with two partners, and we're currently
looking for a venture capital firm to invest in us. How will the
equity be divided among us and the VCs?

A: One
of the most common questions I get is about how equity should be
distributed. I'll warn you in advance: There are no hard and
fast rules. Equity is negotiated on a case-by-case basis, which
makes it hard to give any generalizations. I'll try to give
some thoughts on what to consider when you give out equity.

Dividing Equity Among
Founders
Founders receive equity for what they bring to the table. How much
of the company they own as a result of their contribution is purely
up to the group to decide. There are several factors that need to
be considered, however.

Timing, size and duration of contribution: The earlier,
bigger or longer the contribution to the company, the more equity a
founder should receive.

Power: Equity conveys voting power and control over the
business. Generally, founders who intend to stay with the business
long-term should retain the most control. I have heard it
recommended that one individual own at least a 51 percent of the
company, to provide consistent decision-making when resolution is
needed. Equal partners, while great in theory, can destroy a
company when the partners don't agree and have no way to
resolve fundamental disagreements.

Money: Early money is a contribution for equity. Money
has the side effect of valuing the company. If you give 10 percent
of the company for someone contributing $50,000, it implies a
company value of $500,000. If you try to raise money immediately
thereafter, that valuation could hurt your negotiating ability. But
if substantial infrastructure has been built in the meantime--if
customers have been acquired or if more of a team has been
built--then a higher angel/VC valuation is justified.

Kind of contribution: A founder may contribute in many
ways. Some bring patents or product ideas. Some bring business
expertise and ongoing work to build the business. Some bring
capital. Some bring connections. Some may bring big names or
reputations which convey credibility with VCs and/or clients. One
big name that provides instant credibility may, in fact, be worth
more to the company than a founder who actually puts in the work to
build the business. Make sure to understand what each founder's
contribution is and value it appropriately.

We Have Five Founders--What Do
We Do?
Negotiate, big-time. Too many founders can be a big problem. As the
company reaches for outside funding, you make many decisions about
equity, contribution and dilution. The more equity-holders, the
more negotiation has to enter into each of these decisions.

Having several founders makes it hard to keep everyone
adequately compensated. By the time of harvest (IPO or
acquisition), the founding group can expect to own about 20 to 30
percent of the company. With one founder, that can mean riches.
With several founders, that may mean splitting the pie into so many
pieces that no one is happy with the value of his or her piece.

In short, fewer major equity holders are better. If you've
already got several, make sure to tie each founder's vesting to
the contribution you're expecting from him or her.

How Much Will Investors Expect
to Own?
The basic formula is simple: If you need to raise $5 million, and
an investor believes the company is worth $15 million, you will
have to give them 33 percent of the company for his money.

Different investors value companies in different ways. Some look
at the quality of the idea, assets, market size and management
team. Some rely on financial projections. Some simply look for
"big ideas" and determine their percentage ownership
purely through negotiation.

I asked a couple VCs, some entrepreneurs who recently received
funding and an angel investor how much of a company is typically
given up in the first round. While one VC had seen investments as
low as 5 percent, the majority thought that first-round investors
usually take between 25 and 45 percent of the equity.

One entrepreneur remarked: "The better thing to ask is, how
much should management and founders try to hold onto before the
IPO? Answer: as much as possible, but no less than 25
percent."

The entrepreneur has an important point. If it comes down to the
money (as it often seems to, these days), what matters is
percentage ownership at harvest multiplied by the valuation at
harvest. Owning 1 percent of a company with a billion-dollar
valuation is still more interesting than owning 10 percent of a
company with a $50 million-dollar valuation.

What Equity Should Part-Time
Contributors Expect?
Not very much. The reality of the situation is that start-ups
usually require 150 percent commitment by everyone involved.
Venture capitalists insist equity be given in return for ongoing
commitment. Even founders who stay with the company have a
multiyear vesting schedule. Many VCs will not allow equity to be
given to part-time employees or contractors.

There is a one-time contribution for stock that is routinely
made: giving capital itself. A cash investment for stock lets the
investor own the stock free and clear, with no further contribution
required. Having part-time contributors purchase stock outright may
be the best way to include them in the deal.

What Does Ownership Look Like
After the First Round?
According to Ann Bilyew of Advent International, a typical first
round is:

Founders: 20 to 30 percent

Angel investors: 20 to 30 percent

Option pool: 20 percent

Venture capitalists: 30 to 40 percent

Stever Robbins is the founder and President of
LeadershipDecisionworks Inc., a national training and consulting
firm that helps companies develop the leadership and organizational
strategies to sustain growth and productivity over time. His web
site is http://LeadershipDecisionworks.com.